Column: Executive Pay: Time for CEOs to Take a Stand

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For some time now, CEO pay has been a lightning rod for criticism and debate, but CEOs themselves have stayed pretty quiet on the topic—often because it’s uncomfortable for us to speak out about how others are paid and simpler to leave it to our compensation committees. Our well-intentioned advisers—HR leadership, outside consultants and lawyers, even board members—avoid the subject, fearful of sending the wrong message to a high-performing CEO. So it’s time for CEOs to speak up about unacceptable and inappropriate amounts and forms of compensation—particularly since “say on pay” shareholder votes are on the horizon. If we don’t take the lead, Congress and others will, in ways that may be in no one’s best interest. Here’s what I propose:

Reward with equity.

Every element of a pay package should strengthen the CEO’s stewardship of the firm, providing incentive to consistently create value over the short, medium, and long term. It should align him with the company not only when he is active but also in retirement, because the surest measure of his contribution is the quality of succession and the business’s performance in the year or two after he hands over the reins. For this reason I strongly believe that equity should make up the lion’s share of a CEO’s retirement package.

Restore integrity to equity grants.

Let’s also require that CEOs hold a meaningful portion of their company-awarded equity into retirement. This sets an example by affirming the company’s long-term values and culture for other top executives. It’s painless—many CEOs already do it—but it underscores the importance of the long-term health of the enterprise.

I strongly believe that equity should make up the lion’s share of a CEO’s retirement package.

In some cases a CEO may have accumulated so much equity that additional grants provide little incremental motivation. At that point the CEO should ask the compensation committee to put those grants back into the pool for other employees.

Eliminate post-employment provisions not pegged to performance.

So-called safety-net provisions such as outsize change-in-control or severance payments and supplemental retirement plans are indefensible—as are “mega equity grants” that are way out of proportion to the CEO’s contributions. Stock options were never intended to be automatic. Their purpose is to recognize extraordinary individual performance, to align the CEO clearly with shareowners, and to encourage longer-term value creation. A CEO who has amassed sufficient wealth to provide for any eventuality needs no security blanket.

Implement more-detailed analyses.

A few years ago companies started using tally sheets to ensure that all the components of an executive’s compensation could be seen in one place. We should adopt two additional analyses: walkaway wealth accumulation and internal pay equity. The first pulls together the total wealth an executive will take with him under various termination scenarios. Whereas the tally sheet is a front-end snapshot, the walkaway provides a full picture, including the outcome of all the gains (realized, unrealized, and projected) from all previous (and pending) grants. The internal pay equity analysis adds up all the components of an executive’s compensation going back several years, to determine whether one of them may have distorted pay ratios.

Cynics may say, “Lafley can afford to talk this way because he already got his.” In fact I had no employment contract, no severance, no change-in-control payments, no gross ups, no pension (beyond stock from a modest profit-sharing trust that all P&G employees participate in), and no supplemental retirement plan, and 90% of my pay was at risk in the form of restricted stock and stock options. I truly hope and believe that if we as a group embrace—and implement—the tenets above, we will have come a long way toward restoring public trust in our system of democratic capitalism.

A version of this article appeared in the May 2010 issue of Harvard Business Review.